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Bumps Ahead: Can You Ignore the Bad News and Prosper?

Many investors began the year with great hope that this would be the corner we were all hoping we would round. Markets were poised to go higher and that belief spurred some interesting volatility. But stock markets are very fickle mechanisms, designed to frustrate the experts and befuddle those who are not. And now that half the year has ended, the whole of the economy seems poised to, well, let’s put it this way, do what is least expected. And yet, we should have expected it all along.

There has been a basket of economic news that was not received well by those who see the stock market as the main wealth generator, perhaps all that is left for most. But when the thought of staying in a marketplace that has disappointed and thrilled, all in the same week, most of us become understandably skittish. We have seen the second quarter of 2010 create nothing but trouble with the Dow Jones Industrial Average falling 6.27 percent (and poised to go lower).

The question is not how low it can go but what you can do. The ugly news forcing buyers to become sellers has been in the background, much like the vuvuzelas of the 2010 World Cup all along. And like the droning sounds of an approaching insect swarm, we have been little fazed by the noise. Annoying yes, but until we are actually in a position where we can’t ignore the noise do we try to run for cover.

In the U.S., the jobs number released this morning only added to the mounting pressures. From the private sector, the one that is supposed to create jobs and get the ball rolling, the disappointment was most noticeable with only 83,000 jobs created in the past month. Even as the unemployment rate dropped, due to the loss of unemployment benefits to thousands of workers, the lack of interest in taking a risk, any risk, put thoughts of a double dip recession on the minds of most investors.

Should the problems of a global proportion have any impact on what you do with your retirement accounts? Only if, and this is a big if, you are retiring this year or next. Otherwise, look at it this way: few of us get another chance at buying what in normal times would be considered a great purchase for less than what it is really worth.

The stock market is built on buyers who believe that something good is about to happen or will continue to happen, and sellers who believe that whatever has happened will make their original decision to buy no longer viable. When sellers sell, the thinking goes, they know something you might not. When buyers buy, on the flip side, you believe they know something you that you should know but do not.

This creates the herd mentality often seen in euphoric run-ups and disastrous sell-offs. You know they know something and based on what you know and don’t, you follow. You can’t rely on your stand-alone judgment to determine whether the problem is real or imaginary. You follow the herd and run from the danger even if you are unsure of what the danger is.

History is filled with instances where those who waited to see what was happening and who perished unnecessarily. Jeffrey Kluger wrote about this in his book Simplexity when he suggested that we are always trailed by danger in some form in part because we are not so good at distinguishing long-shot risk from those that are the most likely. He points out one example of how we fear mad cow pathogens in our hamburger but ignore the cholesterol; how we worry about shark attacks at the beach but forego sunscreen.

So when the market offers us a buying opportunity—remember a seller may or may not know something, may or may not be simply taking a profit or may or may not have bought erroneously at the top and now recognizes their mistake—do we see it for what it is? Do we move against the herd or do we run with the pack? It is no easy decision to make.

But here’s something to consider: Volatility is here to stay. It is the new stock market paradigm. No longer will there be slow, almost excruciating climbs to the top. This was your grandfather’s stock market where little trust was put in the ability of Wall Street to create more wealth than the simple act of buying a home and saving money. Credit was scarce and worth working for—once you had it, you could say you had financially arrived.

The pace picked up dramatically in the early ’80s and continued unabated for the almost eighteen years. This was the greatest wealth creation period for the stock market—ever. And it will never happen again. Although there were numerous reasons as to why, the best was the creation of the 401(k) and the demise of the pension. Moving from defined benefit to defined contribution forced folks into the market and with it, a lot of buyers.

Since then, those buyers y default have wondered whether this was a good idea as evidenced by the decade following that period of downs and ups followed by the biggest downer, 2008. This leaves us with one option: do what works.

For the moms visiting this site, falling back on the three key principles that should guide your financial life will lessen that angst. The first of which is to make sure you have your personal accounts in order. More than simply budgets, which are absolutely necessary, the ability to project your costs over a long period of time will be the easiest part of the equation. If you are apending more than you earn then you should stop.

The second basic tenet espoused by legendary investors is to fund your future. Even with all of the pitfalls that the 401(k) is, you should still continue to invest. Even with no company match, you should be putting money away, pre-tax in this plan. It provides an opportunity to do so in a measured way, forcing your portfolio to buy more when the market is down and buy less when it is up.  Using actively managed funds in these accounts, diversified over a variety of sectors won’t save you from down markets but it will give you a more mobile opportunity to do better when they recover. (Indexers will take me to task on this last one with arguments about fees, and they are well understood as a subtractor of future wealth, but these funds move with the herd whereas actively managed funds will not. Additionally, these funds sell losers and buy winners when they rebalance, which is counterintuitive.)

The third principle of an investor is what Benjamin Graham called the mad money account. Should you have some money leftover after adjusting your household expenditures, after funding your retirement, then and only then, should you buy individual stocks.

As Kluger wrote: “Rational calculation of real-world risks is a multidimensional math problem that sometimes is entirely beyond us.” Each of these three ideas attempts to calculate the real-world risks. Taking care of what you can see in front of you, investing in what you know will come in the future and gambling on your own ability to understand your risk last doesn’t make the bad news go away; it simply makes the ugly bumps the in the road more tolerable.

Paul Petillo is the managing editor of and a regular contributor to MomsMakingaMillion radio.